Like most things there are things integral to growth, things that must be constantly injected into that subject to allow for growth until its natural end. Food is to animals as cash flow is to a business. Cash flow is basically money that is injected into a business to meet day to day expenses. In this article I will provide 1st a basic description of cash flow, 2nd How it works and last a few ways to ensure good cash flow in a business.
1. Cash flow is used on aspects of business like payment of employees, utilities (electricity, water, internet etc.), loan payments, rents (housing, storage facilities like ware houses), insurance (property, health etc) and taxes among others. One of the major goals as described by Steven rogers in his book Entrepreneurial finance for the serious entrepreneur is that when dealing with your cash flow you should be able to ensure you have enough cash on hand to meet the demands for cash at any given time, the major demands being those that I have listed above.
The major sources of cash flow include the accounts receivable (Goods yet to be paid for), cash payments, other income (any investments of the business) and borrowing. Cash is not necessarily for only maintaining a business but also for growing a business. Happiness for a business man theoretically must be in having a positive cash flow, what does this mean, having more than enough cash to meet the many demands of the business and a little extra to use for useless stuff like buying a private jet to taunt traffic officers.
2. A business’ cash flow is commonly termed or described by an acronym which is EBITDA which in full is (EBI) Earnings before interest, (T) Taxes, (D) Depreciation and (A) Amortization. Amortization means the ideal spending to derive profit from producing a product by spreading the cost of producing the product (Josh Kaufman, the personal MBA) e.g. Investing in an industrial oven that can bake 500 cup cakes at a time instead of a normal oven that can bake only 20 at a time leading to increased short term spending to derive a higher longer term profit. EBITDA when added up is equal to cash flow and it is the cash which can be used to service debts, pay taxes, buy capital equipment and return profit to the investor and or shareholders after paying the companies operating expenses.
Note that EBIDTA and free cash flow are mostly ideal situations to be in but unfortunately, many businesses tend to be far from this ideal. Why? Because on paper the company may be shown to be making money yet in actual sense it isn’t because much of the money owed to the business hasn’t been paid. The company could have had an extraordinary month of growth in revenues such that all the companies’ cash had to be used to finance its growth in demand by paying more employees and paying for raw materials or ingredients used to make the products. For example in a bakery, if most of the cupcakes were bought on the last week of the month and the terms of payment are not cash payments since they were large scale purchases but promises instead, such a scenario can describe a situation where on paper your cash flow may look strong because you have made many sales yet in reality your business is as thirsty as a dried plant because the cash payment will not arrive for another 2 weeks or even a month thus your cash flow will take a hit.
3. To avoid such situations many books e.g. Entrepreneurial Finance for the serious entrepreneur recommends serious vigilance about maximizing day to day cash flow of the business. As stated earlier a business needs sufficient cash flow for day to day business and that is why you need an efficient cash flow management system to properly manage both cash receipts(cash inflows) and payables(cash outflows). Failure to have a good cash management system will in the case of the bakery cause more and more of the expenses to eat into the company’s profits in the end leaving the company dry. Think of the 2007 CHOGM vehicles for a second, if the supplying company had only produced those vehicles and waited for the Uganda government to pay them before growing their business……, in the words of a famous politician the providers would until now in disbelief say “mujooga”.
Cash flow is an aspect of the business that must be looked at every day since money must as well be spent every day. However, though inconclusively, I suspect many are guilty of ignoring their cash flow managements system especially when business is going well. In the case of the bakery it’s possible that the owner would ignore things like how the small expenses are handled for example fuel for deliveries, wasted cupcakes that are not bought etc. until it hits the owner in the face that a lot of cash has been mishandled. Steven Rogers notes that the stronger the economy is and the faster the company grows, the easier it is to overlook cash flow controls. Seth Godin notes that business is cyclical thus what you are earning now you will need to spend later since you need money to make money. Thus you may ignore the cash flow concerns now without even having to face immediate repercussions but in the future the industry or even the economy may face a down turn and that is when your business will have to squeeze both its butt cheeks because it will receive a serious lashing and your focus will have to come back to where your cash flow is directed.
Note therefore that cash is more important than the number of customers that owe you because eventually you will use all your lines of credit before getting paid and stabilizing. Solutions to the cash flow problem include making good cash flow management systems and good cash flow forecasts. The management system was discussed earlier so I’ll go into detail with the cash flow forecasts.
Preparation of a business forecast as discussed in Steve Rogers’s book enables an entrepreneur to determine a business’ financing needs. If the business owner forecasts that there is likely to be a cash shortage, then outside financing has to be accumulated in order to continue running for example using the cupcake business if you forecast that usually the clients take some time before paying you then money will have to be sourced in order to allow the bakery to continue running. A good cash flow forecast will allow the business owner to determine how much is needed and when it is needed. Forecasts can be up to 5 years in the future.
Another important aspect in improving your cash flow is the time between your accounts receivable e.g. Payment by the clients who got the cakes and your accounts payable e.g. bills etc. having these two at the same time can also be a problem. Imagine a scenario where at the time you are slated to receive payment for your work is the same time all your monthly bills pile up. It can be troublesome trying to grow, thus these two must be spaced, so if you are paid at that beginning of the month then bill should come earliest in the middle of the month, to allow time to stabilize and manage expenses without choking.
In relation to cash forecasts, cash flow ledgers are also an important tool in indicating all cash received and disbursed on a transaction basis in that month thus the entrepreneur will be able to assess the company’s ability to fund its monthly operations and also meet the debt payments as they come due.
All in all, cash flow management in a business is among the major tools that must be given due attention to help your business stay afloat but even more than that it will help in growth.